FALLING COMMODITIES ARE SIGN OF RECESSION -- SO ARE FALLING MATERIAL AND ENERGY STOCKS -- IT'S IMPORTANT THAT MARKET STAY ABOVE 2002 LOW -- WATCHING BANDS FOR OVERHEAD RESISTANCE
COMMODITES ARE LAST ASSET TO PEAK... A number of readers have asked if I thought the U.S. was in a recession or heading into one. Others have asked if I thought this recession would be worse than most. Although I'm not an economist, it is possible to make some judgements about the direction of the economy by looking at various financial markets. Two of them are stocks and commodities. On July 18, I wrote an article suggesting that commodities were peaking based on a number of technical indicators. That article also contained a headline that read: "Commodities Peak During Bear Markets". Here is an excerpt from that earlier message: "At the end of an economic expansion, stocks usually peak before commodities. If stocks enter a bear market (and a recession starts), commodities usually enter a downside correction as well. During the stagflation years of the 1970's, serious downturns in stocks caused profit-taking in commodities. The commodity rally resumed after the stock market and the economy turned back up again." Stocks lost half of their value during 1973 and 1974 which led to a recession the second year. Commodities also dropped during that recessionary year. Historical studies show that stocks peak anywhere from six to nine months before the economy. From October 2007, that would put the outer target for an economic peak in July 2008 which is when commodities peaked.
Chart 1
STOCKS PEAKED NEARLY A YEAR BEFORE COMMODITIES ... Chart 1 is an updated version of a similar chart shown on July 18. The chart compares the S&P 500 (top line) to the CRB Commodity Index (bottom line). The earlier article pointed out that it had been a year since the topping process started in stocks and,"with stocks having reached the bear market threshold of 20%, the time seems ripe commodities to enter a corrective phase". They've certainly done that and more.
Chart 2
GLOBAL RECESSION ... The weekly CRB Index bars in Chart 2 (plotted through Wednesday) show commodities tumbling 40% since their October top. That's a huge drop by any standard. The bars also show the CRB threatening its 2007 low which would put the commodity index at the lowest level in nearly four years. [The CRB traded below 280 today with virtually all commodity markets in the red]. What makes the CRB plunge so dangerous is that it's occurring as part of global downturn. The green line on top of Chart 2 shows a positive correlation between the Euro and commodities (both trend in the opposite direction of the dollar). The Euro has also plunged along with most foreign currencies on weakening global economies. That makes the current recession global in scope which is more serious. To get a further idea of how weakening global demand has hurt some key commodities, Chart 3 shows crude oil losing half its value since July. Chart 4 shows copper plunging to a three-year low and showing signs of a major top. Copper is one of the best barometers of the global economy. Its weak chart pattern doesn't bode well.
Chart 3
Chart 4
THAT'S WHY BASIC MATERIALS AND ENERGY STOCKS ARE SO WEAK ... Another recessionary sign comes from the fact that basic material and energy stocks have become the weakest part of the market since July. Chart 5 shows the S&P 500 (black line) peaking last October. The Basic Materials SPDR (blue line) started dropping during June and the Energy SPDR (red line) a month later. Chart 6 plots those two commodity ETFs relative to the S&P 500 (flat black line). It shows both commodity groups starting to underperform the market for the first time during July. That's significant. A July 3 Market Message explained why: "Basic materials and energy are market leaders at a market peak. As the economy starts to slow, money starts to rotate out of those two inflation-sensitive groups. Basic materials peak first and energy last. This week's downturn (July 3) in basic material stocks suggests that the topping pricess is moving even further along. Energy may be the next to roll over...One way we can tell that a bottom is near is when money starts to flow into financial and consumer discretionary stocks. So far, there's no sign of that happening." The 40% drop in stocks and commodities, combined with the collapse in material and energy stocks, are all recessionary signs.
Chart 5
Chart 6
S&P 500 STILL IN HUGE TRADING RANGE... The monthly bars in Chart 7 are intended to put the current bear market into some perspective. Over the last year, the S&P 500 has lost 40% of its value. That compares to a 50% loss from 2000 to 2002. The 1973-1974 bear market also cost the S&P 500 half of its value. [The 1987 decline only lost a third]. That puts the current bear market right up there with the two worst bears in the postwar period. The only difference is time. The current bear has happened in a much shorter period of time. Let's hope that's not a bad omen. Chart 7 shows a huge trading range for the S&P 500 between the 2000 highs and the 2002 lows. It seems likely that the 2002 bottom will be tested sooner or later. I put it that way because there's always the possibility of a fourth quarter bounce (which would be pretty normal). The 14-month RSI (top of chart) shows the S&P in the most oversold territory in six years. Unfortunately, the 12 month Rate of Change (ROC) line below the chart has already broken its 2002-2003 low (as have many of our other long-term indicators). To me, that means that any bounces should be kept within the context of an ongoing bear market until proven otherwise. To answer the original question that we started with, I believe the U.S. economy is in recession. Today's report that U.S. industrial production fell the most since 1974 has an ominous ring to it, and suggests that the recession could be worst than the last one in 2001. To prevent something even worse from happening, let's hope the S&P stays above its 2002 low.
Chart 7
THREE WAYS TO USE BANDS ... I recently showed how to use Bollinger band width to measure market volatility. That's the black line on top of the daily S&P 500 bars in Chart 8. [Scroll down the Indicator menu to "Boll. Band Width"]. The rising line since September means that the two Bollinger bands are widening which implies rising volatility. That's bearish. The upper line has to turn down for any rally to occur. The line beneath the chart plots the two Bollinger bands around the flat 0.50 line which is the 20-day average. [Scroll down Indicator list to "%B"]. That line shows the market to be in a short-term oversold condition. A bounce back to the middle line seems likely. That would be the dashed 20-day average which currently sits just above this week's intra-day high at 1044. Prices would have to clear the 20-day line to signal a more serious rally. On Monday, I plotted hourly Bollinger bands to spot initial overhead resistance. The hourly bars in Chart 9 shows the S&P 500 trading within its hourly bands. That more sensitive chart also puts initial resistance near this week's high.
Chart 8
Chart 9
VIX CLOSES LOWER ... Chart 10 shows the CBOE Volatility (VIX) Index hitting a new high day before closing lower. That downside reversal coincided with an upside reversal in stocks. Any hopes for a market rebound rests with a pullback in the VIX. That's why today's close is mildly encouraging. Today's lower close also puts the VIX back below its upper Bollinger band (see circle). If the VIX does pull back from here, it should find support near its 20-day average (see arrow).
Chart 10
